Your superannuation is one of the most important, not to mention tax efficient, ways to save for life after your retirement. Unfortunately, almost half of Australians aged between 45 and 64 do not feel confident
they have adequate funds to do what they want in retirement. Having the right plans in place to manage and grow your super can make a significant difference to your retirement goals. For some, this includes managing their own super independently through a self-managed superannuation fund (SMSF).
An SMSF is your own personal super fund that gives you control to make the important decisions around how your super is invested. Managing your own super through an SMSF can be extremely rewarding, but they aren’t for everyone because they require your close attention and dedication. In this article, I will take you through the 5 steps of investing in property with your super.
First thing first, let’s address the elephant in the room, what is super borrowing? Simply put, it is a loan to your SMSF (Self-Managed Superannuation Fund) trustee to purchase an investment asset. By law, the trustee of a regulated superannuation fund, which includes SMSFs, can not borrow money. However, it does allow an SMSF trustee to borrow money to acquire certain kinds of assets, including residential investment property, provided that certain conditions are met.
One of these conditions is that any rights of the lender or other person against the SMSF trustee is limited to the asset acquired with the borrowed money. This is what is often referred to as a ‘limited recourse’ loan.
A Superannuation loan is a loan to your SMSF trustee for the purpose of financing or refinancing the acquisition of a residential investment property.
Let’s use the simple scenario below to illustrate the general process of super lending
James, 51 is an IT account manager, and his wife Grace, 49 a doctor, together have been contributing to standard industry superannuation funds for many years. They sought professional advice, and took all the necessary steps to set up their own SMSF called The Jamesgrace Super Fund – in doing so, they also choose to have a corporate trustee for their SMSF (Jamesgrace Pty Ltd) of which they will be the directors.
Step 1. Legal
James and Grace have set up a SMSF and chosen to have a corporate trustee for their SMSF (Jamesgrace design Pty Ltd) of which both of them will be the directors. They also set up a security holding trust, to which the vendor will transfer the legal title. The holding trust will become the legal owner of the property, while the SMSF is the beneficial owner and receives the rental income.
During the term of the loan, the legal title to the property is held by the trustee of their security trust – as required by superannuation law, while loan repayments are made by the SMSF itself.
Step 2. Understand if the numbers stack up
When considering whether to borrow against super to invest, it’s important to determine if the net investment returns are likely to exceed the after tax cost of borrowing. James and Grace have done their due diligence by gathering the available data about the property being considered for purchase, the loan and associated structuring costs (including the costs related to the SMSF arrangements).
James and Grace decided that they want to include residential property in their SMSF’s investment mix. So they sought legal advice regarding borrowings for their SMSF. They have $300,000 in cash in their SMSF and have found an investment property worth $500,000 which they would like to purchase.
As the directors of Jamesgrace Pty Ltd (the corporate trustee for their SMSF), James and Grace arrange to buy the property and use $175,000 in cash to make an initial payment for the property. The shortfall of $325,000 plus $25,000 in stamp duty and acquisition costs is funded by a ‘limited recourse’ loan, using the property as security.
Step 3. Apply for the loan
James and Grace arrange for a loan to be provided to their fund in order to cover this shortfall. The SMSF will initially qualify for the loan as the SMSF:
Meets the pre-purchase minimum net asset position of $200,000
Passes the liquidity test of at least 10% of total assets, after settlement. The SMSF will still have $125,000 remaining as liquid assets after the purchase has been completed.
Both James and Grace are also required to provide the lender with personal guarantees for this loan.
Step 4. Repay the loan
Income from the rent, other SMSF investments and James’ and Grace’s super contributions can all be used to repay the loan. In addition, James and Grace choose a variable interest rate loan option and link a 100% offset account to it. This means that every dollar their SMSF holds in the Offset Deposit Account effectively reduces the amount of interest the fund will pay on the loan.
Step 5. Paying off the debt
The super borrowing arrangement will end once the loan is paid off, and the title of the security will be transferred from the security holding trust to the SMSF.
Above are the very high level steps that you will need to go through to invest in property using your super, and this is only the tip of the iceberg as there are other tips and things you also need to consider to maximize your super borrowing. If you like this article, please visit my blog for more articles on creating wealth via property.